Corporate Failures - KPMG

Corporate Failures

Forensic

kpmg.co.za

Corporate Failures

Contents

Executive Summary Introduction The reasons for corporate failures Auditors: the role they played/didn't play No governance over fraud The pressure cooker syndrome The capability to commit fraud Policing fraud Conclusion Summary Appendix 1 ? Background to global case studies Appendix 2 ? Sources Appendix 3 ? About the authors

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2 7 9 10 18 20 22 27 28 33 34 38 41

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Executive summary

Fraud does not Much research has been done globally to measure fraud, many articles

always result in corporate failure, nor do corporate failures

have been published recommending additional mechanisms to prevent and detect fraud. Court sanctions of convicted fraudsters do not appear to deter and additional legislation and

occur only as a result regulation appear to have little impact in reducing the occurrence of fraud and,

of fraud. However, in hence, corporate failures. The research, conducted on nine case some of the biggest studies across the globe, revealed

corporate failures various commonalities in some of the biggest corporate failures due to

across the globe, fraud, namely: ? Greed or sense of making magic

fraud was involved. happen

No single model can ? Over-ambitious corporate expansions leading to complex

successfully predict structures

the risks of fraud or ? Excessive debt to fund expansions or personal expenses

the fact that fraud ? Incentives to management increase is occurring or has the motivation to commit fraud

? Pressure to achieve market

occurred. expectations

? Corporate governance failures as a result of incompetent or ineffective boards and board committees

? Sense of entitlement by senior management

? Failure and override of internal controls

? Manipulation of financial records and/or fraudulent financial reporting to disguise the true nature of underlying problems

The main theme that was observed throughout the research is that a variety of role players, factors and circumstances culminated into these corporate disasters. The following summarises the main themes observed in the case studies.

The role of the auditors

Auditors have been criticised, investigated and taken to court. Many articles were written in attempts to understand the role that auditors played or didn't play and whether they should have known that fraud was occurring within the organisation. The independence of relationships between clients and auditors have come under scrutiny. The quality of audit work performed was considered to be of less than desirable standard where corporate failures occurred.

Finally, consideration has also been given to the expectation that

auditors should identify fraud and whether that expectation is

realistic.

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M Bhasin, author of "Corporate accounting scandal at Satyam: A case study of India's Enron", stated that audits would only detect approximately 10% of frauds. The Association of Certified Fraud Examiners maintains that audits are ineffective although it is the most widely used mechanism to detect fraud and prevent losses.

Bridging the expectation gap is therefore a process of creating awareness among investors and shareholders of the scope of the financial statement audit and the value it provides as well as what it cannot provide. Auditors are not required to analyse all non-financial data of a company, some of which could indicate fraud risks.

Corporate governance failures

Corporate governance was also touted in many instances as the main reason for corporate failures. Attempts at curbing these failures in the form of more stringent legislation and regulation does not appear to have had the desired impact. Due to the various causes of corporate failures, corporate governance failures cannot be regarded as the sole contributing factor to corporate failures.

The case studies revealed numerous governance issues, including inter alia the following:

? Non-independent board and audit committee members, for example where a CEO fulfilled multiple roles in various committees

? Inadequate governance structures, for example, lack of board committees or committees consisting of a single member

? Inappropriately qualified members, for example, family members holding board positions or audit committee members not having appropriate accounting and financial qualifications or experience to analyse key business transactions

? Ignorance by auditors, regulators, analysts etc of the financial results and red flags

? Management, who deliberately undermines the role of the various governance structures through the circumventing of internal controls and making misrepresentations to auditors and the board

It therefore appears that more regulation has not resulted in

more effective governance over corporates.

Implementing the regulatory and best practice guidelines for good corporate governance has been a costly and cumbersome exercise for most companies. The implementation of "better" governance structures has become a checklist exercise to ensure compliance.

The major risk still being observed during various forensic investigations indicates that the mind-sets of management and those tasked with governance have not really changed. Some members of governance structures are not aware of the onerous positions that they hold and the full extent of the responsibility and accountability ascribed to them.

Pressures present when fraud occurred

The pressure cooker syndrome considers the internal and external pressures that the leaders of organisations suffering corporate failures endured, putting some of the responsibility at the door of each stakeholder, banking institution, analyst and the public that missed the red flags.

The committing of fraud is intended to benefit the organisation, for example overstating profits, but may benefit management through bonuses based on profitability.

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